Wednesday, May 27, 2009

USA vs. other AAA-rated entities

AlphaNinja - There was much debate this week about the possibility of the United States losing its coveted AAA rating, after S&P downgraded the UK. As I wrote at the time, we need to take these ratings with a grain of salt, as the performance of the ratings agencies has been awful to the point of being a contrary indicator.

After PIMCO's Bill Gross suggested the USA could also be downgraded, a slew of people came out to call that a longshot. But why shouldn't our credit rating be downgraded? Here is how the USA stacks up against a few other "bulletproof" AAA-rated names:

Uncle Sam's annual interest expense, as a % of revenue, is 100times that of ExxonMobil, yet they have the same credit rating. There's obviously "concentration" risk by owning XOM debt versus the vast, diversified USA revenue base, but the numbers still speak loudly. In under a decade we're going from Debt/GDP of 50% to 100% or worse, and expect that not to dent our credit rating. It's like assuming your FICO score doesn't budge after you take a 10% wage cut and take out a mortgage.

This Drudge screenshot exemplifies the double standard between the US and the "little guy":

The UK's debt to GDP is over 300%, while ours is around 80% - so I'm not worried that we're about to lose our status as the best place to safely "park" money. But to think that our massive borrowing and spending should have no impact on our creditworthiness is absurd.

"Federal tax revenue plunged $138 billion, or 34%, in April vs. a year ago — the biggest April drop since 1981, a study released Tuesday by the American Institute for Economic Research says."

Numbers like that mean that we may not have a stable enough "revenue" base to support the borrowing we're attempting.

Minyanville's Mr. Practical, with sobering but critically important warnings:

"Of course we have stabilized. The government has bankrupted our future to do it. The government(s) control the LIBOR market, the swaps market, the bond markets with all the “money” they are printing. They are feeding “money” to banks under the table at an alarming rate.Those declaring the economy is now recovering do not understand (still) the problem: we are stuck with too much debt. The government’s solutions are to create more debt, as their next to be announced PPIP does. But an economy grows from production, not lending at the wrong price. This is a long term problem; the government has only addressed the short run symptoms.Let me give you an example. Sixty to 70% of our economic growth depends on consumption. In order to “reflate” an economy (still the wrong way to do it but I will give the bulls the fact that you can drive up nominal asset prices by devaluing a currency), you need people to borrow money and spend it. In 2002 consumer debt as a percentage of disposable income was an all-time high of 90%.

Apparently that was still low enough to spur consumers into borrowing money against their houses and spend it. This drove the ratio up to 135%! By the first quarter of 2009 the ratio dropped to about 130%. Just look at what damage that did as consumers tried to get out of some debt. The ratio is still at least 125% (we will know for sure in at the end of June as the numbers are quarterly). There's no way to know for sure, but logic says to reflate from that high level of debt is going to be virtually impossible.The government is going all out socializing markets and the economy. This is the exact opposite approach I would take. We need lower debt, not more. We need production, not lending. Unfortunately I offer no solutions other than let an economy grow from the bottom up, by savers finding a good investment and lending to entrepreneurs. When the government provides capital (printing) money, it crowds out production.Risk is very high."